Class Action Waivers in Arbitration Agreements are Valid under Federal Arbitration Act (FAA) and California’s Discover Bank Rule, Which Found Such Waivers Unenforceable as Unconscionable Under State Law, is Preempted by the FAA Supreme Court Holds
Plaintiffs filed a putative class action in California federal court against AT&T Mobility, with whom they had cellular telephone service, alleging “false advertising and fraud by charging sales tax on phones it advertised as free.” AT&T Mobility LLC v. Concepcion, ___ U.S. ___ (April 27, 2011) [Slip Opn., at 2-3]. According to the allegations underlying the class action complaint, plaintiffs purchased cellular telephone service from AT&T based on an advertisement for “free phones” because, even though they were not charged for the telephones, “they were charged $30.22 in sales tax based on the phones’ retail value.” Id. Defense attorneys moved to compel arbitration, id., at 3. The cellular telephone service contract required arbitration of disputes between the parties and included a class action waiver, providing that claims must be brought in a “individual capacity, and not as a plaintiff or class member in any purported class or representative proceeding.” Id., at 1. Plaintiffs opposed arbitration on the grounds that the class action waiver was unconscionable under California law. Id., at 3. Despite viewing the arbitration agreement “favorably,” the district court denied AT&T’s motion to compel arbitration because the class action waiver rendered the arbitration clause unconscionable under California law based on Discover Bank v. Superior Court, 36 Cal.4th 148 (Cal. 2005). Id. The Ninth Circuit affirmed, holding that “the Discover Bank rule was not preempted by the FAA because that rule was simply a ‘refinement of the unconscionability analysis applicable to contracts generally in California.’” Id., at 3-4 (citing Laster v. AT&T Mobility LLC, 584 F.3d 849, 857 (9th Cir. 2009). The Supreme Court granted certiorari and reversed.
The service agreement was consumer-friendly: It provided that a customer could initiate a dispute by filling out a one-page form available online, and if not resolved to the customer’s satisfaction within 30 days, the customer could initiate arbitration by filling out another form available online. If a customer commenced arbitration proceedings, the arbitration would be held “in the county in which the customer is billed” and AT&T was required to “pay all costs for nonfrivolous claims.” AT&T Mobility, at 2. (The customer could also elect to proceed in small claims court. Id.) Moreover, if the amount in dispute was less than $10,000, then the customer could elect whether the arbitration should be conducted “in person, by telephone, or based only on submissions.” Id. Additionally, “the arbitrator may award any form of individual relief, including injunctions and presumably punitive damages.” Id. AT&T was prohibited from seeking reimbursement of its attorney fees, and “in the event that a customer receives an arbitration award greater than AT&T’s last written settlement offer,” then the service agreement “requires AT&T to pay a $7,500 minimum recovery and twice the amount of the claimant’s attorney’s fees.” Id. (footnote omitted). Yet despite what appears to have been every effort to craft an arbitration clause favorable to its customer, albeit prohibiting class actions, the lower courts found the arbitration clause unconscionable and unenforceable under the Discover Bank rule. The Supreme Court reversed.
The High Court began by reiterating that the FAA reflects “both a ‘liberal federal policy favoring arbitration,’ [citation], and the ‘fundamental principle that arbitration is a matter of contract,’ [citation].” AT&T Mobility, at 4 (citations omitted). The FAA requires the arbitration clauses be enforced except “upon such grounds as exist at law or in equity for the revocation of any contract.” Id., at 5. This means that “agreements to arbitrate [may] be invalidated by ‘generally applicable contract defenses, such as fraud, duress, or unconscionability,’ but not by defenses that apply only to arbitration or that derive their meaning from the fact that an agreement to arbitrate is at issue.” Id. (citations omitted).
The Supreme Court then turned to the Discover Bank rule, where the California Supreme Court held, in analyzing the enforceability of a class action waiver in an arbitration agreement:
“[W]hen the waiver is found in a consumer contract of adhesion in a setting in which disputes between the contracting parties predictably involve small amounts of damages, and when it is alleged that the party with the superior bargaining power has carried out a scheme to deliberately cheat large numbers of consumers out of individually small sums of money, then … the waiver becomes in practice the exemption of the party ‘from responsibility for [its] own fraud, or willful injury to the person or property of another.’ Under these circumstances, such waivers are unconscionable under California law and should not be enforced.” 36 Cal.4th at 162 (citation omitted).
Plaintiffs argued that the Discover Bank rule was not preempted by the FAA because it prohibited class action waivers in all contracts, not simply arbitration agreements. AT&T Mobility, at 6. The Supreme Court found the issue to be whether the unconscionability doctrine was being “applied in a fashion that disfavors arbitration.” Id., at 7. So viewed, the Court provided several illustrations of cases where a court could find an arbitration agreement “unconscionable” under a rule that “would have a disproportionate impact on arbitration agreements” even though generally applicable to other contracts as well. See id., at 7-9. In the end, the Supreme Court held that “nothing in [§2’s saving clause] suggests an intent to preserve state-law rules that stand as an obstacle to the accomplishment of the FAA’s objective.” Id., at 9 (citations omitted). The reason is simple: “a federal statute’s saving clause ‘”cannot in reason be construed as [allowing] a common law right, the continued existence of which would be absolutely inconsistent with the provisions of the act. In other words, the act cannot be held to destroy itself.”’” Id. (citation omitted). In the High Court’s view, “Requiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA.” Id.
The Supreme Court’s analysis is well worth reviewing. See AT&T Mobility, at 9 et seq. In broad terms, the FAA was “designed to promote arbitration.” Id., at 11. And while the Discover Bank rule “does not require classwide arbitration, it allows any party to a consumer contract to demand it ex post.” Id., at 12. Given the purposes of arbitration (such as confidentiality, streamlined procedures, limited discovery, circumscribed appellate review), “class arbitration, to the extent it is manufactured by Discover Bank rather than consensual, is inconsistent with the FAA.” Id., at 13. At bottom, “Arbitration is poorly suited to the higher stakes of class litigation.” Id., at 16. In the High Court’s opinion, “We find it hard to believe that defendants would be the company with no effective means of review, and even harder to believe that Congress would have intended to allow state courts to force such a decision.” Id., at 16-17 (footnote omitted). “Because it ‘stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress,’ [citation], California’s Discover Bank rule is preempted by the FAA.” Id., at 18.
NOTE: Justice Thomas filed a concurring opinion, expressing the view that the opinion should have turned on the simple fact that “the FAA requires that an agreement to arbitrate be enforced unless a party successfully challenges the formation of the arbitration agreement, such as fraud or duress” and that “a district court cannot follow both the FAA and the Discover Bank rule, which does not relate to defects in the making of an agreement.” AT&T Mobility, at 1-2 (italics added) (citations omitted) (Thomas, J., concurring). Justice Breyer filed a dissenting opinion, joined by Justices Ginsburg, Sotomayor and Kagan, which argued that California’s Discover Bank rule was not preempted by the FAA because it concerned “certain circumstances in which ‘class action waivers’ in any contract are unenforceable,” and not simply arbitration agreements. AT&T Mobility, at 1 (Breyer, J., dissenting).
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